IYM ETF: Materials Dashboard For January

This monthly article series shows a dashboard with aggregate industry metrics in materials. It is also a review of sector ETFs like the Materials Select Sector SPDR ETF (XLB) and the iShares U.S. Basic Materials ETF (NYSEARCA:IYM), whose largest holdings are used to calculate these metrics.

Shortcut

The next two paragraphs in italic describe the dashboard methodology. They are necessary for new readers to understand the metrics. If you are used to this series or if you are short of time, you can skip them and go to the charts.

Base Metrics

I calculate the median value of five fundamental ratios for each industry: Earnings Yield (“EY”), Sales Yield (“SY”), Free Cash Flow Yield (“FY”), Return on Equity (“ROE”), Gross Margin (“GM”). The reference universe includes large companies in the U.S. stock market. The five base metrics are calculated on trailing 12 months. For all of them, higher is better. EY, SY and FY are medians of the inverse of Price/Earnings, Price/Sales and Price/Free Cash Flow. They are better for statistical studies than price-to-something ratios, which are unusable or non available when the “something” is close to zero or negative (for example, companies with negative earnings). I also look at two momentum metrics for each group: the median monthly return (RetM) and the median annual return (RetY).

I prefer medians to averages because a median splits a set in a good half and a bad half. A capital-weighted average is skewed by extreme values and the largest companies. My metrics are designed for stock-picking rather than index investing.

Value and Quality Scores

I calculate historical baselines for all metrics. They are noted respectively EYh, SYh, FYh, ROEh, GMh, and they are calculated as the averages on a look-back period of 11 years. For example, the value of EYh for packaging in the table below is the 11-year average of the median Earnings Yield in packaging companies.

The Value Score (“VS”) is defined as the average difference in % between the three valuation ratios (EY, SY, FY) and their baselines (EYh, SYh, FYh). The same way, the Quality Score (“QS”) is the average difference between the two quality ratios (ROE, GM) and their baselines (ROEh, GMh).

The scores are in percentage points. VS may be interpreted as the percentage of undervaluation or overvaluation relative to the baseline (positive is good, negative is bad). This interpretation must be taken with caution: the baseline is an arbitrary reference, not a supposed fair value. The formula assumes that the three valuation metrics are of equal importance.

Current data

The next table shows the metrics and scores as of last week’s closing. Columns stand for all the data named and defined above.

	VS	QS	EY	SY	FY	ROE	GM	EYh	SYh	FYh	ROEh	GMh	RetM	RetY
Chemicals	-14.94	8.05	0.0514	0.4467	0.0085	21.94	40.11	0.0437	0.4557	0.0215	17.99	42.61	4.05%	-6.23%
Constr. Materials	44.07	60.41	0.0673	0.9705	0.0397	24.06	30.35	0.0328	0.8858	0.0338	11.14	28.92	4.48%	-20.86%
Packaging	-6.70	14.58	0.0692	1.1277	0.0112	23.51	24.08	0.0484	1.0591	0.0368	17.67	25.04	2.77%	-6.73%
Mining/Metals	70.89	88.04	0.0726	1.3450	0.0527	23.73	24.69	0.0429	1.1871	0.0229	9.22	20.82	8.98%	2.74%

Value and Quality chart

The next chart plots the Value and Quality Scores by industry (higher is better).

Value and quality in materials (Chart: author; data: Portfolio123)

Evolution since last month

The value score has moderately deteriorated across the sector, the most in chemicals.

Score variations (Chart: author; data: Portfolio123)

Momentum

The next chart plots momentum data.

Interpretation

Mining/metals is the best-ranked industry regarding both value and quality scores, followed by construction materials. Both subsectors are significantly undervalued relative to 11-year averages. Packaging and chemicals are overvalued by about 7% and 15% using the same metrics. They are close above the historical baseline in quality. As a whole, the basic materials sector was overvalued by about 10% when I published January’s broad market dashboard.

Fast facts on IYM

The iShares U.S. Basic Materials ETF (IYM) has been tracking the Russell 1000 Basic Materials RIC 22.5/45 Capped Gross Index since 6/12/2000. Its total expense ratio is higher than XLB: 0.39% vs.0.10%.

The fund has 39 holdings, and it is very concentrated: the top 10 companies represent 64.5% of asset value. The top name, Linde, weighs almost 19%.

Ticker	Name	Weight	EPS growth %TTM	P/E TTM	P/E fwd	Yield%
LIN	Linde plc	18.83	11.11	44.20	27.74	1.40
APD	Air Products and Chemicals, Inc.	8.09	10.58	30.89	27.36	2.08
FCX	Freeport-McMoRan, Inc.	7.63	0.02	17.11	19.13	0.83
NEM	Newmont Corp.	5.27	-50.26	43.10	29.44	4.05
NUE	Nucor Corp.	4.92	90.28	4.95	5.55	1.29
DOW	Dow, Inc.	4.83	-0.01	7.61	9.13	4.77
ECL	Ecolab, Inc.	4.45	0.40	39.35	34.52	1.37
IFF	International Flavors & Fragrances, Inc.	3.65	-661.74	N/A	21.08	2.79
ALB	Albemarle Corp.	3.43	597.64	18.37	11.53	0.65
FAST	Fastenal Co.	3.43	20.51	26.26	25.95	2.54

IYM has underperformed XLB by 68 bps in annualized return since inception (see next table). It also shows a higher risk measured in drawdown and volatility (standard deviation of monthly returns).

	Total return	Annualized return	Max Drawdown	Sharpe ratio	Volatility
IYM	478.15%	8.08%	-67.78%	0.38	22.81%
XLB	565.26%	8.76%	-59.83%	0.44	20.55%

In summary, IYM offers a capital-weighted exposure in basic materials companies of the Russell 1000 index. It currently holds 39 stocks including large and mid-caps, whereas XLB invests in 32 large companies. IYM has a capped weighting methodology to avoid excessive concentration in top holdings (22.5% by company, 45% aggregate in companies weighing more than 4.5%). It is more expensive than XLB in management fees, and behind it in total return since 2000. Moreover, XLB is a better instrument for trading and tactical allocation, thanks to much higher trading volumes. Investors who are concerned by risks related to the top holding weight may prefer the Invesco S&P 500 Equal Weight Materials ETF (RTM).

Dashboard List

I use the first table to calculate value and quality scores. It may also be used in a stock-picking process to check how companies stand among their peers. For example, the EY column tells us that a chemical company with an Earnings Yield above 0.0514 (or price/earnings below 19.46) is in the better half of the industry regarding this metric. A Dashboard List is sent every month to Quantitative Risk & Value subscribers with the most profitable companies standing in the better half among their peers regarding the three valuation metrics at the same time. The list below was sent to subscribers several weeks ago based on data available at this time.

OLN	Olin Corp.
VRTV	Veritiv Corp.
CLF	Cleveland-Cliffs, Inc.
CC	The Chemours Co.

It is a dynamic, monthly list with a statistical bias toward excess returns on the long term, not the result of an analysis of each stock.